The Dollarization of Ecuador

An evaluation of the effects of Ecuador’s decision to dollarize – Phill Waugh

Advertisements

Dollarization is the process of aligning a country’s currency with that of the U.S. dollar. Like El Salvador, Ecuador decided to dollarize in an effort to provide its citizens and economy much more stability. Throughout the late 1990’s, Ecuador experienced a terrible economic crisis that caused the value of the Sucre, Ecuador’s previous official currency, to fall at an incredible rate. By the year 2000 the inflation rate was just over 96 percent and the citizens had already begun using the USD informally. Within the year the country joined Panama, El Salvador, and other developing countries around the world and decided to officially dollarize.

The decision to dollarize does not come without its consequences, both good and bad. It is most important to note that dollarization had its intended impact on Ecuador by bringing stability to the economy and quelling its obscene inflation rates. So much so, within three years of dollarization the inflation rate was back down to single digits where it has since remained. Dollarization provides further stability through decreased transaction costs when trading with other countries as the USD is such a prominent currency worldwide. Not only are these transaction costs mitigated but exchange rates are much more stable on the global scale. Many citizens also find comfort in that their government is not in control of monetary policy and it must make up for this with seemingly transparent fiscal policies such as changes in taxes.

In the case of Ecuador, it seems to have a more positive influence on the economy but it does have its pitfalls. Oddly enough, while many enjoy the idea of putting their government in a position to have to be transparent, there are those who would argue the lack of control over monetary policy is dollarization’s most regrettable attribute. This proved to be a real issue in 2008 when the U.S. was going through what we now refer to as “The Great Recession” and there was little Ecuador could do from being impacted as well. Inflation rates went up over 8 percent that year, the highest it has been since it’s come down from Ecuador’s initial dollarization in 2000. This lack of access to monetary policy is unfortunately not only limited to times of economic strife. It also means that Ecuador is incapable of strategic devaluation which could lead to a surge in exports.

The particular issue highlighted in the article published by El Comercio focuses on the recent appreciation of the USD, particularly against the Colombian Peso. This appreciation of the USD has had many negative effects on the Ecuadorian economy, most notably, a diminishing exchange rate and Purchasing Power Parity (PPP) between Ecuador and Columbia. Without access to monetary policy, there is little the Ecuadorian government can do to influence this issue.

While this appreciation has given Columbia an incredible boost in competitive prices for goods, it continues to impact Ecuador’s economy negatively. Such incredibly competitive prices have led Ecuadorians, even those on the other side of the country, to plan semi-annual trips to Ipiales, Columbia, a small town just on the other side of the northern border, where they can purchase the exact same brand goods for between 30 to 60 percent less. These goods are so much cheaper that it is actually monetarily beneficial for Ecuadorians to travel, shop for months worth of goods, stay in a hotel, and travel back over the course of a couple days as opposed to just shopping locally. Those who can make same day trips almost always do because there is no incentive to purchase anything on the Ecuadorian side of the border.

With Ecuadorian citizens continually going abroad for goods as simple as toiletries and coffee on a consistent basis, the economy is always suffering from enormous cash outflows. These outflows leave the country at risk of causing stunts in their own economic growth. What is worse is that these stunts would likely only be emphasized if Ecuador were to attempt to de-dollarize their economy and return to the Sucre. The instability of the Sucre and lack of control of monetary policy leaves Ecuador’s economy between a rock and a hard place.

Even if Ecuador could and wanted to de-dollarize, it would not have a large positive impact on their exports because they are an oil producing country which is standardized by the USD. In this case, de-dollarizing would only incur the transaction costs that they had eliminated to begin with. If the Ecuadorian government could find some fiscal policy that were to influence the exchange rates between Ecuador and Columbia so that they were not so out of control then they might be able to even out the PPP and keep more business on their side of the border.

Despite the cash outflows and being at the mercy of American monetary policy, Ecuador has reaped many benefits that other Latin American countries have not, such as increased trade with the U.S. Even with the troubles Ecuador faces as a dollarized country, they are much better off for it and the economy is as stable as it has ever been.

Buyer number 25 only pays half the total of his bill. This promotion is heard in a speaker of the Alkosto Hypermarket, one of the most visited self-service places by Ecuadorians in Ipiales (Colombia). Promotions like this, which are applied from Monday to Friday, continue to attract hundreds of nationals, who cross the bridge of Rumichaca, to go shopping. The appreciation of the dollar against the Colombian peso is another factor that affects and even compensates for many the expenses in transportation, food and lodging . To verify the difference in prices, a team from EL COMERCIO DATA traveled to Ipiales to buy USD 100 in basic products, which are currently the most demanded in the neighboring country.

The purpose was to make a comparative of prices, including the taxes that are taxed in each city. Overall it was found that in Ipiales cost USD 96.82 less than in Quito, which accounted for 34% of difference. The conversion of the currency was made at 3312 pesos per dollar, which was the change to June 2016, when the trip was made. Yesterday, September 20, the change was 2928 pesos per dollar, which would mean about 10 dollars more to the invoice of purchases made in Colombia. For Aurora Sánchez, 38, this difference is significant for her economy and for this she travels with her siblings once a month. It prioritizes purchases between products of toilet and certain provisions, which are cheaper. For example, in Quito, a shampoo of the same brand and presentation costs USD 8, while in Ipiales it is USD 5, including all taxes. In other products the difference is greater: a bottle of 85 grams of soluble coffee costs USD 6.32 with 14% VAT, while in Ipiales it reaches USD 2.39. For Santiago Mosquera, a professor at the USFQ – Business School, The main reason for maintaining a high level of purchases in Ipiales is the exchange rate of the currency. “The Colombians have allowed their currency to depreciate against the dollar and this gives them greater competitiveness in the relationship Ecuador vs. Colombia”.

In addition to the exchange rate, wages are lower in Colombia, so it is cheaper to produce there, says Mosquera. The basic salary in the neighboring country is 689 454 pesos; If calculated at 3312 pesos for each dollar is equivalent to USD 208, while in Ecuador, the minimum wage is at USD 366. Another attraction that Ecuadorian entrepreneurs see in Colombia are the efforts they have made in the last five years to improve their Profile as recipients of foreign investment. The Colombian economy ranks 54th in the Doing Business 2015 ranking. This World Bank classification takes into account if the regulatory environment is more favorable for the creation and operation of a local company. Ecuador is on site 117 in this list. According to estimates made by Amador Anchundia, 67, there are toiletries and groceries that are almost 40% cheaper in Ipiales. But he believes that for Ecuadorians living near the border is more convenient because they can return the same day and do not incur additional hotel or gas costs. He lives in Manabí but his family is in Quito. Daniela Recalde and her husband are aware of the extra expenses so they prefer to go by bus and return the same day. They travel every four months, mainly, to buy toiletries, sweets , Coffee and sometimes clothes . They target between USD 100 and 150 for shopping and travel. Entrepreneur Harold Delgado , president of the Chamber of Commerce of Ipiales, points out that having a depreciation of the Colombian currency, production is less expensive and this makes the local industry grow and attract more and more Ecuadorians …

2 thoughts on “The Dollarization of Ecuador”

Phil, I really liked the way you explained how Ecuador has been able to benefit post dollarization. I was under the impression that with dollarization, a country gets extremely susceptible to the foreign currency, but it was interesting to see your perspective on this and tracking how positively Ecuador has been able to respond.
On of the questions I wanted to ask was whether the foreign trade between Ecuador and other countries had fallen? Since the dollar has seen to be appreciated, that would mean that their good get more expensive and thus other countries would want to purchase more of them. Does this impact their foreign trade and if so how are the financial markets being able to tackle the rising inflation and costs?

What might the uncertainty around Ecuador’s currency mean for the optimal savings and debt decisions of households? Would they be better off taking loans (e.g. for business investment) at current rates?

About

This blog is a project for Econ 416: Theory of Economic Development, at the University of Maryland. Posts are contributed by undergraduate students, and do not represent the views of the University of Maryland.